As big funds vanish, start-ups stare at M&A for survival

Experts argue that the top two players in each category will receive funding sooner or later, but for laggards, the market is still challenging.

Illustration: Dominic Xavier/Rediff.com

In the last few weeks, several start-ups raised money: Zomato, Swiggy, BigBasket, and Zoomcar were among the prominent names.

Has the funding cycle turned for start-ups? The big deals may suggest so, but they don’t reflect the full story.

While the outlook is positive, there’s hardly any sign of angel activity returning.

According to a top executive of a venture capital firm, the pace of investment is picking up after the slowdown in 2016 and a large part of 2017.

“Most of the discount and high-burn behaviour of the companies was rationalised during 2016 and 2017 and the surviving companies have made good progress in the last two years, which is resulting in a good number of Series C, Series B, and Pre-Series B deals,” he said.

The executive attributed the low deal flow on the seed side to a ripple effect of 2015, when many companies started and then died.

On top of that, imposition of angel tax, too, has reduced angel investments in the last six to eight months, analysts pointed out.

Ankur Warikoo, founder, Nearbuy (earlier Groupon India) that was bought by Paytm, said the past two years were a cleansing period, when funding dried up and only those that had either built scale or had positive unit economics survived.

“This year, these will be rewarded. There was never a dearth of capital. With the cleansing, these opportunities are much clearer.”

But, Dhruv Agarwala, chief executive officer of PropTiger, which acquired rival Housing.com, does not think there is a funding cycle turnaround yet.

“The issue is that barring Alibaba/Ant Financial, Naspers/Tencent, and SoftBank, there are really no other investors writing large cheques,” he said.

Among the recent deals, Zomato, Swiggy, and BigBasket have been funded by the Alibaba Group and Tencent, while Zoomcar has raised money from Mahindra & Mahindra, which has a strategic intent.

Experts argue that the top two players in each category will receive funding sooner or later, but for laggards, the market is still challenging.

Anybody who’s not No. 1 or 2 will find it difficult to raise late-stage capital unless the froth returns, which is not imminent, according to analysts.

So, while there is a spurt in late-stage deals for category leaders or challengers, deal activity has slowed down in early stage, while the crunch continues in Series A/B/C.

In fact, after the hype in 2015, investors are taking more time to close deals.

According to a study last year, the average age of start-ups raising angel funding in 2015-16 was 1.8 years, which increased to 3.8 years in 2017.

Also, only 24 per cent of the start-ups that raised money in 2016 were generating revenues; in 2017, 88 per cent of the start-ups that raised money were generating revenues.

“It is a vicious cycle. A slowdown in angel or seed stage deals means fewer companies getting to Series A,” says Ashish Sharma, CEO at Temasek-backed InnoVen Capital.

A virtuous cycle works the other way, like in 2015, when there was excess liquidity.

There’s one more trend: VCs are doing more follow-on rounds in investee companies.

While VC firms have dry powder of $5 billion to $7 billion, many VCs are doing follow-on rounds in companies they have invested earlier -- if they are bullish, they are investing in proportion to their share and even leading the Series B rounds in these companies.

“There is enough supply of capital, but there is a flight to quality.

"How many start-ups raising Series A/B/C money are able to achieve what they promise?

"The say-to-do ratio has to be a lot higher,” said Sharma.

In any case, not all companies raising Series A will get Series B, and not all raising Series B capital will be able to raise a Series C round.

There’s much learning from all this.

Suresh Narasimha, founder, CoCreate Ventures, said, “We now know it takes a lot of money to build venture scale business and we have the metrics to spot the winners.”

Series A will see lesser companies, higher valuations, and higher fund infusions, he pointed out.

This could result in a rush of consolidation across the sector.

“I am seeing higher dollar invested per angel, but lesser angels per syndication, and definitely more stringent control and terms.

"We will see more active investors than what we have seen earlier,” said Narasimha.

Sandeep Murthy, partner at venture capital firm Lightbox, believes the true potential of the investment opportunity in India will be realised with the emergence of large super-consolidators who will drive the M&A (mergers and acquisitions) market.

“In the US and China, we saw that four companies play the role of aggregators in each market.

"These four players in each market (Google, Amazon, Facebook, and Apple in the US; Baidu, Alibaba, Tencent, and Xiaomi in China) all come from the same four verticals -- search, e-commerce, social networking, and devices.”

In India, the US and Chinese players will be vying for dominance in these verticals along with well-funded Indian start-ups like Flipkart, Hike, and traditional Indian companies such as Reliance, M&M, and Tata Group, according to Murthy.

This trend is already playing out, with a few strategic deals announced this year, and there are more in the pipeline.

“I think M&A transactions between bricks and clicks will be quite a rage,” said Sushanto Mitra, founder & CEO, Lead Angels.

M&A transactions will generate exits for early-stage investors that could trigger a turnaround for early-stage deals by the last quarter of this calendar, he added.